Target Date Funds 101

Target Date Funds 101

What You Should Know Before Investing in a Target Date Retirement Fund

Generally as you age, your investments should move from riskier, higher-return stocks into more conservative bonds to avoid major losses near retirement. The classic method is to invest your age in bonds – for example, 60% bonds and 40% stocks at age 60. However, this model does not take into account what your planned retirement age will be, how much money you will need in retirement, and your progress toward meeting your goals.

Target date funds look at a particular target date for retirement and your expected needs at that time, and they will adjust your portfolio accordingly. They are popular for company 401(k) plans because of their relative ease of management and hands-off approach – the fund managers are automatically doing the rebalancing for you. That is also why many individual investors find it appealing if they lack the skill, time or interest to do their own fund rebalancing.

Because of this hands-off approach, it is vital to perform advance research to find the plan that best meets your retirement goals. You don't adjust within a target fund to match your risk tolerance and aggressive/conservative approach – you do that upfront by your choice of funds.

Target date funds may be listed as aggressive, moderate, or conservative, but you need to dig deeper to make an informed decision. Here are some details to consider.

Initial Equity Level – The aggressive phase may start at different levels. Can your risk tolerance handle 90%+ in equities during this phase? Do you have aggressive retirement needs that require even higher equity holdings? This stage is where most of your money will be made, so choose wisely.

Glide Path – The rate of change from the growth phase into the conservative phase. Compared to the age models' straight-line changes, target dates represent more of a curve, or have two distinct phases to hit the target.

Glide paths may be "to" or "through" – distinguished by what you plan at your retirement date.

"To" plans reach your most conservative ratio at retirement age and stay there – generally assuming your needs are covered or that you will liquidate and buy a different financial vehicle such as an annuity to guarantee income.

"Through" plans hit your defined target at retirement age but assume that is not the most conservative point. They still assume growth at retirement and get more conservative later in your retirement.

You must find your tolerance for risk, balancing potential losses in retirement with a “through" plan versus the possibility of outliving your funds in a "to" plan.

Fees – Fees vary widely based on the holdings and the level of aggressiveness required. Fees of 0.5% or less are preferable. At the end of 2012, the average fees were 0.7%.

Dig through the fund prospectus and see what you are getting for your fees – and whether the anticipated performance is worth the fee.

Historical Performance – This is hard to gauge on target funds because the target is not always to maximize growth. Still, you can get online reviews of the fund's performance for reference.

Choosing a target date fund is analogous to finding a spouse. Do all of your research upfront and select wisely to avoid unpleasant surprises later. In both cases, making a wise choice will lead to a happy and fulfilling retirement.